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Pension fund executives were among leaders in the effort to reform the financial system and end the doctrine of too big to fail and the practice of bailing out major financial institutions. During the debate on financial reform, the Council of Institutional Investors, representing major pension funds, sent a number of letters to Christopher J. Dodd, then-chairman of the Senate Committee on Banking, Housing, and Urban Affairs, and other senators calling for strengthening corporate governance provisions that had contributed to the market crisis. That reform effort culminated in the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Yet, some pension funds themselves have come to be seen by some as too big to fail, and have become the subjects of potential bailouts.

The issue has become part of the presidential campaign, with the Republican Party inserting it in its national platform. It raises alarms about underfunding of public and corporate pension plans.

Leading up to the financial market crisis, an overriding concern of major public and union pension funds was the systemic risk posed to the financial system by excessive risk taking by financial institutions that was putting at risk trillions of dollars of retirement assets and the financial security of pension system.

Ironically, pension funds have contributed to the financial systemic risk they have sought to reduce. Public pension plans pose a systemic risk to the financial health of states and municipalities, while corporate plans threaten the sustainability of the Pension Benefit Guaranty Corp.

The underfunding of state pension plans amounts to $767 billion, according to a study by the Pew Center, released in June. The unfunded pension obligations of the largest 100 corporate defined benefit plans totaled $454 billion, according to a Milliman Inc report, released in October.

In a report issued in September, Republican members of the congressional Joint Economic Committee warned that “governors and mayors will inevitably come to Washington requesting federal bailouts” of their retirement systems. “And despite the massive federal debt and fiscal imbalances, it will be hard for Washington policymakers to deny sympathetic retired teachers, police, and firefighters after a previous Congress bailed out Wall Street and the U.S. automakers.”

The warning was probably designed to head off such an effort.

States and municipalities have to rectify their own underfunding. The blame for the underfunding of retirement systems, on the public level, lies generally with legislatures, which have raised pension benefits to unaffordable levels while failing to contribute actuarially required amounts to properly fund obligations. They've also kept assumed return rates high, making plans appear better funded than they are.

On the corporate level, sponsors have sought and won pension funding relief from Congress in recent years, shortchanging the plans and worsening funding levels.

Despite the mood against bailouts, relief could come in a “soft” form, Eileen Norcross, senior research fellow with the State and Local Policy Project at the Mercatus Center at George Mason University in Arlington, Va., noted in a story in Pensions & Investments. “I don't think it'd be very popular if it was phrased (as a pension bailout), but it could come in the form of a soft bailout, like an education funding package.”

The problem is a so-called soft bailout has been under way through stimulus spending to state and local governments as well as auto companies. The stimulus spending that went to states and cities helped them postpone hard decisions, including those about benefit levels for public employees.

The stimulus spending wasn't designed as a pension bailout, but money is fungible. Because of the federal rescue of
General Motors Co. and
Chrysler Group LLC, the two companies were able to keep their pension obligations, rather than offloading them to the PBGC.

Congress might be able to stop pension bailouts, but soft bailouts through federal assistance will continue, indirectly providing some relief from a pension reckoning.

To try to put pensions on a better funding course, Congress, in its new term, ought to revive something like the Public Employee Pension Transparency Act, introduced in 2010, that sought to compel more discipline in financial management of public employee pension funds.

It would require better disclosure of pension funds and a more realistic valuing of obligations. In addition, Congress ought to end funding relief measures, while the Financial Accounting Standards Board ought to move forward with integrating pension finances directly with corporate income statements, providing a timelier image of the impact on a plan sponsor.

Pension plan executives cannot invest their way out of the underfunding mess, but until their sponsors improve funding, they will have to rely on better risk management of their investments to keep funding levels from getting worse.

Such moves would reduce the need for bailouts from the federal government.

This article originally appeared in the October 15, 2012 print issue as, "Rescue is no way out".